Your emotional risk tolerance is a major subset of your overall investment risk tolerance.
Yes, your health, age, life stage, income and prevailing personal and economic circumstances are also important contributory factors that will influence your disposition to handling investment risks.
Just like how your emotional intelligence highly affects the effective application of your intelligence, so does your emotional risk tolerance affect your capacity to handle risks.
This goes beyond being happy when an investment gains favourably or being sad when an investment loses value.
The effect of poor emotional risk tolerance could be the loss of your life when an investment goes sour – yes, you may even die. But worse yet, you may live without the joy and hope you had had before a major investment setback.
However, the way you feel about and respond to various circumstances and events is uniquely you. Such emotions are critical to wholesome investing. Exploring the various emotions of investors, we can consider two main angles: the feelings and reactions when contemplating the investment and the feelings and reactions during the investment life cycle.
Some personalities may be prone to wide-ranging emotional swings. Other personalities are quite phlegmatic.
Most of us are some way in between this widely differing range of emotions. Nevertheless, nearly everyone displays a range of varying emotions during the entire investment cycle.
Investment brokers are quick to point out to their clients that the investments with the likeliest chance of success are long-term and diversified. Long-term gives the entire cast of players in the market an opportunity to go through all the emotions.
Diversification can give the investor who keeps a close eye on the make-up of the portfolio, the chance to cheer with the positive performers and to cry with the losers in the portfolio.
In order to make adequate allowances for your emotions when investing, it is important that you get to know yourself. Ask yourself: “How would I feel if I lost all of my invested funds? How would I feel if the return on my investment was lower than expected, than my friend’s or relative’s, than I stipulated, than the bank deposit rate or than the rate of inflation?
“Do I tend to have mood swings, bouts of depression or euphoria, driving fears, regrets or daring feelings? Am I prone to long periods of seclusion or procrastination?
“Do I lose my cool in a crisis? Do I know how to ask for help, how to seek counsel and how to listen? Do I lose sleep, feel ill, or become depressed/impulsive when things don’t go my way? Am I tolerant of my mistakes and myself?”
If you take the time to honestly answer these questions, looking for examples in all areas of your life so far, you will be well on the way to assessing your emotional risk tolerance.
Deeply considering your emotional responses, along with the other contributory factors, will provide a better understanding of what your overall risk tolerance is about. Every good financial advisor and investment broker will try to garner some of this information about you in order to serve you better.
Financial advisors and Investment brokers are specially trained not only to assess risks, but also to evaluate their own disposition to risks. Yet when they are dealing with other people’s money, the emotional response to varying performing investment is muted by the fact that it is the client’s portfolio.
It is in your interest to assess your emotional risk tolerance and protect yourself by only undertaking an acceptable and bearable level of investment risk.
